A Teachable Moment in the PLCB Debate

Those of us who have been parents or teachers often talk about “teachable moments.” Teachable moments occur when something problematic happens from which we can learn some important lesson.

The bills being considered today to privatize the operations of the Pennsylvania Liquor Control Board (PLCB) give us teachable moments — moments that might help people understand why we cannot simply privatize the Pennsylvania Liquor Control Board without the state losing $300-400 million per year in General Fund Revenues.

HB 991 would create new franchise liquor stores for every 6,000 residents in a county with a minimum of 15 per county. That would create as many as 2,000 new liquor stores — far more than the 601 state stores already in place.

The bill has a provision that is quite peculiar, but ultimately very revealing: it requires the PLCB to sell wine and spirit products to franchise stores for the same price that the PLCB acquired the product from a wine or spirits producer. The PLCB is not only allowed no wholesaler or distributor’s markup on what it sells franchise stores, it is not even allowed to recoup its overhead costs for receiving product from distributors and delivering it to franchise stores.

As a result of this provision in the law, the PLCB will be subsidizing franchise stores, reducing the profits it returns to the state budget each year. That means, first, that this law is designed not only to open new retail stores, but to undermine the PLCB and take us one step closer to complete privatization of its operations.

And second, it shows that this step by step undermining of the PCLB does not move us closer to what proponents of privatization say they want — free market capitalism — but instead, it is a form of crony capitalism, in which the private owners of wholesale and retail liquor operations get favors from the state.

Will anyone be surprised if part of this deal turns out to involve the politicians who support it receiving rewards from the cronies they benefit?

This peculiarity of the legislation not only points to the bad faith of the privateers, but if we see why it is in the legislation, we will understand something important about the existing system of liquor sales in Pennsylvania — the state will lose an enormous amount of revenue from liquor sales if the PLCB is totally eliminated.

To see this, you need to understand why the privateers can’t allow the PLCB to pass along even a wholesale markup, as is done in almost every industry and would surely be done if the PLCB were privatized.

The answer is that the PLCB’s markup on liquor prices is far lower than that received by wholesalers and retailers in other states. The PLCB is both the wholesaler and retailer of wine and liquor and its markup over the price it pays its suppliers is about 30%. The wholesaler markup for wine and liquor in other states typically runs from 18-25%. But the retail markup is typically 33-50%. So the total markup when liquor and wine is sold by private businesses is typically 51-75%.

Given the low markup of the PCLB in both wholesale and retail, in order for franchise stores to be make the usual retail markup, they can’t pay the PLCB any markup at all and still have competitive prices.

Why is the PLCB markup so low? The answer to that question brings us to a critical point for understanding the impact of the PLCB on state finances: Pennsylvania has among the highest liquor taxes in the country. Those liquor taxes are made possible in part by the PLCB’s low markup. And it is those higher liquor taxes that generate substantial revenues for the General Fund.

It’s difficult to see how high our taxes are because Pennsylvania never instituted the kind of gallonage tax that other states have — that is a tax per gallon of wine and spirits sold — and has kept in place the 18% tax on liquor sales, known as the Johnstown Flood tax. In 2017-2018, taxes on alcohol are projected to bring in $413 million. (Profits from the operation of the PLCB are projected to total another $185 million.)

It’s not straightforward to compare the 18% tax to the gallonage taxes found in other states. The best attempt to do so is in an excellent report written by Nathan Lutchansky. Lutchansky is a supporter of privatization, but an honest one who recognizes that the costs to the state of privatization will be substantial.

Lutchansky makes a rough comparison by dividing the number of gallons sold into the total tax take for both wine and spirits. (His report uses Pennsylvania sales data from 2010-2011. We will update it soon. But there is no reason to think that Pennsylvania alcohol taxes at a per gallon rate have changed much. Indeed, as prices increase, our tax per gallon has no doubt increased.)

Pennsylvania’s tax on wine in 2010-2011 was roughly the equivalent of a tax of about $5.08 per gallon. The national average in 2016 was 94 cents per gallon, and in New York it was 30 cents per gallon. Our tax on liquor was roughly the equivalent of $9.60 per gallon in 2010-2011. That national average in 2016 was $7.30 per gallon and in New York it is $6.64 per gallon for liquor over 24% in alcohol strength.

Our taxes are far higher, but our liquor and wine prices are comparable to other states. How is that possible? The answer is what we saw above, the PLCB's markup is far lower than the usual combination of wholesale and retail markup.

The PLCB system has a much lower markup than private business can accept. And that makes it possible for the state can tax liquor at higher rates. What that means, however is if the state hands wholesale and retail liquor sales to the private sector, if we continue the step by step dismantling of the PLCB system, the state will have to dramatically reduce its liquor tax, costing the state hundreds of millions of dollars in revenue. Either liquor taxes come down or liquor prices will rise far higher than those in neighboring states. And which will reduce sales substantially and lead to a public outcry against privatization.

The proponents of liquor privatization tell us that we can have complete privatization of liquor sales and still generate the yearly revenues the current system contributes to the General Fund. That’s simply not true. This legislation shows us the truth: privatization not only would cost the state the profits of the PLCB ($185 million in 2017-2018), but it will force us to cut our liquor taxes ($410 million in 2017-2018), by up to half. The cost to the state of complete privatization would thus be roughly $300-400 million a year.

In recent years, the General Assembly has balanced the budget by borrowing from the future. Balancing the 2017-2018 budget by moving closer to dismantling the PLCB is budget gimmickry on steroids. It will help close the deficit this year at the cost of generating larger deficits every subsequent year.

UPDATE: April 5

HB 991 was amended in committee to allow the PLCB to add a 15% markup to what it would charge the new franchise stores. This improves the bill from one point of view: the PLCB won't be subsidizing the franchise stores. But it raises other questions and creates a dilemma. On the one hand, it's not clear whether people will step forward to buy franchise licenses if, after paying the PLCB markup, they can only markup their products by another 15% before becoming uncompetitive with state stores. On the other hand, if franchise stores cannibalize state stores sales, then the PLCB will be securing less revenue for the state budget, and putting the PLCB at risk.

Either way, the fundamental point of this essay remains true: we can't privatize the wholesale and retail operations of the PLCB without threatening an importance source of state revenues.

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